BNY Mellon: The USD and Treasury Yields

Rising Treasury yields through the 1960s and 1970s did not prove USD supportive

Sustained USD strength has only emerged during times of tight monetary conditions

The jury is out on the medium-term outlook for USD

It is worth recalling that there have only been two primary trends in 10-year Treasury yields throughout the past 60 years. The first, dating from the 1950s, saw yields rise from around the 2% mark to a high of 15.82% in September 1981.

The early stages of this move were driven by a sizable increase in domestic spending on President Johnson’s Great Society programs as well as an increase in military spending associated with the Vietnam War. However, the latter stages were connected with rising levels of inflation as the Fed focused policy on supporting the US economy.

This period was also associated with growing downward pressure on the USD. In the initial phase this led to a breakdown of the Bretton Woods system that had seen the price of gold pegged at USD 35 an ounce.

While the link with gold began to break down in late 1968, the key moment was the Nixon Shock of August 1971, when the President “closed the gold window”. The final move to free-floating exchange rates came by March 1973.

Although the USD did gain some support from Fed policy in 1973 and 1974 (undermined somewhat by the impact of domestic politics), easy monetary policy settings during the second half of the decade served to erode the USD. The net result was that - between the Nixon Shock and the election of President Ronald Reagan on November 4, 1980 - the USD Index lost around 25%.

The USD began to recover sharply in the aftermath of the November 1980 election of President Reagan, thanks to his promise of a drastic cut in "big government" and a pledge to deliver a balanced budget for the first time since 1969.

Significant support for the USD through this period also came from the Fed under the leadership of Paul Volcker, thanks to a renewed focus on dealing with inflation above all else.

Though the USD suffered throughout most of the rising Treasury yield period, it’s hard to argue that the story has been much better in the time since.

While it is true that three USD bull markets have emerged post-1980, only the first two were associated with relatively tight US monetary conditions. The third - and arguably the weakest - has primarily been linked with ultra-easy monetary policy settings elsewhere.

The net result is a USD Index that stands just 5% above where it was when President Reagan was first elected. Today, the headline inflation rate stands at almost exactly the same level above the Fed fund's target rate as it did going into late 1980 (see table below).

In the short term, it’s hard to argue that a rise in US yields will be anything other than highly USD supportive (which may have implications for EM currencies).

However, the downward pressure that emerged on the USD in the 1960s and 1970s is a strong reminder that sustained higher yields over the longer term may not automatically equate to currency strength.